Greg Mankiw's Blog

Thursday, January 31, 2008

Four Goals of Tax Policy

I thought it might be useful to put the debate over fiscal stimulus in a broader perspective.

When designing a tax system and evaluating tax proposals, policy analysts have at least four goals in mind:

Efficiency: The tax system should distort incentives as little as possible (and, in the case of externalities and Pigovian taxes, correct incentives when necessary).

Intergenerational equity: The tax system should raise enough revenue so current generations do not unduly burden future generations.

Egalitarianism: The tax system should try to achieve a more equal distribution of after-tax incomes.

Stabilization: The tax system should help maintain the economy at full employment.

The current debate over fiscal stimulus involves trading off these goals. The stimulus package being discussed is mainly aimed at achieving goal 4, but it does so at the cost of sacrificing goals 1 and 2 to some degree. Efficiency is sacrificed because the phase out raises effective marginal tax rates and because the higher future taxes that result from the extra government debt will likely be distortionary. Of course, the phase out is there in order to achieve goal 3: This is the classic tradeoff between efficiency and equality.

Differences of opinion arise when policy analysts weight these goals differently. Advocates of fiscal stimulus put a large weight on goal 4. Critics of fiscal stimulus come in two varieties. One type of critic discounts goal 4 entirely because they are skeptical of Keynesian theories that underlie this goal. A second type of critic admits that goal 4 is legitimate in principle but believes that in the current environment macroeconomic stabilization is best left to monetary policy so fiscal policy can focus on goals 1 and 2. I am in this latter category.

The cat is out of the bag

Wednesday, January 30, 2008

Fiscal Stimulus Update

Alex Brill, formerly an economist at the Ways and Means Committee, emails me:

Have you noticed how the stimulus bill is shifting? Only in Washington can there be two definitions of what $150 billion means. The House and the White House wanted $150 billion stimulus in 2008 but the Finance Committee appears to define the $150 billion price tag as the 10-year cost, not the one year cost. Subtle but important difference. As a result they have increased the 2008-2009 cost to $196 billion and the ten year cost is now the "magic" $150 billion. The policy changes? More rebate checks and tax relief for firms with NOLs in 2006 and 2007 (presumably home builders and financial services companies being notable winners).

I think your correspondent gets the "only in Washington" definition backwards. The important fact to understand is that both the House and Senate stimulus plans contain bonus depreciation. That allows companies to take larger depreciation allowances in the first year in exchange for lower depreciation allowances in future years. The one-year cost of the House version is $44 billion but much of that money is recouped so that the net present value is $13.6 billion. Only in Washington (and in this case the House bill that your correspondent seems to implicitly support) would this be described as $44 billion. Any business would use a concept much closer to the NPV.

You get closer to the NPV by using 11 year nominal totals, which taking the entire bills are $117 billion for the House and $156 billion for the Senate. This does not say which is substantively better, but it is the better way to pose the question.

Also, like your correspondent I am skeptical about allowing firms to essentially get tax credits against net operating losses, it does nothing to increase the rate of return to new investment and I do not expect the improved cash flow to have much stimulative effect. But I would have thought you would have agreed with former Bush administration Assistant Secretary for Tax Policy Pamela Olson who argued, "In a perfect world, economists (of all stripes) wouldn't just permit carrybacks and carryforwards, they'd refund losses to taxpayers... So, I would say that it's a good idea, but it will cost revenue, which will have to be balanced against the benefit."

Finally, most policymakers do not realize that the "true-up" that allows taxpayers to claim the best of 2007 and 2008 adds extra complications, has no stimulative effect, and creates the marginal rate problems you identified in your earlier post. Maybe you should see if you could convince folks to drop this provision so that the rebate will be entirely a lump sum transfer, rather than mostly a lump sum transfer.

Tuesday, January 29, 2008

How is Mike Huckabee like Martin Luther King?

John McCain and Mitt Romney are the most like Ronald Reagan whereas (within the set of primary candidates) the words of Mike Huckabee and Barack Obama are the closest to those of Martin Luther King. Hillary Clinton is by far the candidate closest in oratory to Bill Clinton.

Jason Furman vs Steven Landsburg

P(recession now)=0.355

This paper investigates the value of employment data as real-time recession indicators. Among popular monthly labor measures, the unemployment rate is the most useful as an indicator of recession, whereas two top measures of employment growth–payroll jobs and civilian employment–have little value. Two other series, the labor force participation rate and the employment-population ratio, also provide little or no value in anticipating a recession. The best pre-recession employment indicator is actually weekly claims for unemployment insurance (UI). The paper reviews a new technique for predicting recessions, and develops an employment recession probability index. The index indicates a 35.5 percent chance that the U.S. economy is in recession, sharply up from 10 percent last month.

Ed Glaeser on John McCain

Don't believe every rumor you hear

Speaking of Martin Feldstein, who intends to step down in June after thirty-one years at the helm of the National Bureau of Economic Research, the search committee that has been seeking his successor is said to have nearly completed its work. As expected (second item), the front-runners are thought to be N. Gregory Mankiw, 49, of Harvard University, and James M. Poterba, 49, of the Massachusetts Institute of Technology. Both are long-time affiliates of the NBER, which under Feldstein became the nation’s premier venue of applied economic research, with more than 1,000 professors of economics and business publishing under its aegis. The more likely choice is textbook author Mankiw.

I have no idea about whether the search committee is close to a decision, but I am sure that Marty's successor at the Bureau won't be "textbook author Mankiw." The search committee contacted me some time ago to gauge my interest, and after deliberation, I took my name out of the running.

Why did I decide not to pursue the job? As in many such decisions in life, various factors were at play, both personal and professional. But what really pushed me over the edge was pending tax policy. With the Bush tax cuts set to expire in a couple years, I am looking for ways to reduce my taxable income.

Sovereign Wealth Funds

Saturday, January 26, 2008

UI Claims point to a healthy labor market

The chart above shows the number of new claims for unemployment benefits in the first month of the last four official recessions using data from the Department of Labor (claims) and the National Bureau of Economic Research (recession dates).At the onset of each of the last four recessions (1980, 1981, 1990 and 2001), initial claims for unemployment benefits were above the average of 353,000 (from 1967), and in most cases, way above average. The two most recent reports of 301,000 claims (week ending January 19) and 302,000 claims (week ending January 12) suggest that the labor market is healthy and resilient, not weak and anemic.

Jan 31 Update: Bad news today: "In the week ending Jan. 26, the advance figure for seasonally adjusted initial claims was 375,000, an increase of 69,000 from the previous week's revised figure of 306,000. The 4-week moving average was 325,750."

McCain on Tax Reform

He also said that he would consider resuscitating the work of a bipartisan tax-reform commission, appointed by Mr. Bush, whose 2005 report on simplifying the tax code was largely ignored by the administration. Using the process that has been used to close military bases, Mr. McCain said he would ask Congress to vote yes or no on an entire tax-simplification program.

If you had an up-or-down vote on either of the two reform plans described in the report compared to the status quo, the proposed reform would, I predict, get the votes of more than 90 percent of economists. I have no idea how it would do in Congress.

Thursday, January 24, 2008

Proposed Fiscal Stimulus: My View

Several reporters have called or emailed to get my view of the fiscal stimulus agreement announced today. Here it is.

I am personally skeptical that the economic weakness is sufficient at this point to justify such a package. Yesterday CBO came out with its forecast, including "growth for the year as a whole of under 2 percent and an increase in the unemployment rate to an average of 5.1 percent." That is similar to the current predictions of some of the best private forecasters, who put near-term growth between 1 and 2 percent.

In this environment, I would prefer to rely on monetary policy as the main source of macroeconomic stimulus. If there were a stronger case for a short-run demand-oriented fiscal stimulus, I would view the compromise package announced today as reasonable. But given where the economy is right now and the best forecasts of where it is heading, the fiscal package seems unnecessary as a short-run measure, while in the long run adding to the debt burden without doing anything to improve incentives for economic growth.

Addendum: The fact sheet says, "This relief would be available to everyone with adjusted gross income less than $75,000 for singles and $150,000 for married couples filing jointly. It will be phased out for taxpayers above those income thresholds". The phase out is an increase in the effective marginal tax rate. So while the plan gives a short-run boost to aggregate demand, it has a short-run depressing effect on aggregate supply.

Lags in Fiscal Policy

Even if Congress meets its goal of finishing a stimulus bill before March, it is likely to take until June for the government to start sending out the millions of rebate checks that would be the plan's centerpiece. It would take a couple more months before all the checks could be mailed.

The Modern Lighthouse

A classic example of a public good is a lighthouse (even though, as Coase famously noted, it can sometimes be provided as a private good). Because any ship captain can freely see a lighthouse and navigate by it, there are positive externalities to the provision of this good.

A reader points out that the new iPhone takes advantage of the modern equivalent of this externality:

"Every Wi-Fi access point, whether public or private, sends out a signal every second or so, like a lighthouse. We pick up those signals and use our technology to calculate your exact location."

What Skyhook does not do, Skyhook Vice President Shean says, is connect to those Wi-Fi networks. "We're detecting, not connecting."

Tuesday, January 22, 2008

"a strategy of desperation"

My favorite book by Paul Krugman is Peddling Prosperity, which I once assigned in a course and still often recommend to students. A reader recently reminded me what the book says about the use of fiscal stimulus (page 32):

When monetary expansion is ineffective, fiscal expansion...must take its place. Such a fiscal expansion can break the vicious circle of low spending and low incomes, "priming the pump" and getting the economy moving again. But remember this is no by any means an all-purpose policy recommendation; it is essentially a strategy of desperation, a dangerous drug to be prescribed only when the usual over-the-counter remedy of monetary policy has failed.

Monday, January 21, 2008

What I've been watching

This has nothing to do with economics, but for those readers curious what I do in my down time, I have been watching My So-Called Life, the short-lived TV show from 1994, with my family.

My kids are aged 16, 13, and 9, and they all enjoy the show, as do my wife and I. (Admittedly, some of the themes are too advanced for a typical 9 year old, but with two older siblings, Peter gets exposed to stuff earlier than the others did.) The show's writing is superb, and the acting is great. More important, the stories are often a good catalyst for family discussion. The show perfectly captures the feelings, pressures, and conflicts, both at school and at home, that characterize adolescence.

Repugnance

The Clinton Plan

Her first priority, she said, would be changing the tax code. She has proposed tax credits for college tuition, retirement savings, health care and alternative energy use, most of which would go to lower- and middle-income families. She would also raise the top marginal rate to 39.6 percent, its level for much of her husband’s administration. Increasing high-end tax rates would bring in $52 billion a year, her campaign says, and help pay for some of her other proposals.

A few observations:

1. The $52 billion estimate seems high to me. The CBO reports that each percentage-point increase in the top two income tax rates--singles making over about $150K, married taxpayers over about $180K--increases tax revenue by only $6.5 billion in 2009. Multiply that by 4.6 (the proposed rate increase), and you get $29 billion, not $52 billion. And even that $6.5 billion is an overestimate, because it includes the top two rates, not just the top rate. I would guess that the Clinton campaign included other tax increases in the $52 billion figure, such as increases in the tax rates for dividends and capital gains.

2. Even taking the $52 billion estimate at face value, it shows how little revenue would come from increasing taxes on the rich. This is only about 1/3 of one percent of GDP.

3. The passage from Leonhardt makes clear that Senator Clinton wants to spend the extra revenue on other proposals, instead of using it to reduce the long-term fiscal gap.

4. The passage says that this revenue will "help pay" for her other proposals, instead of fully paying for them. The entire package seems to involve either an expanded deficit or other taxes increases (or spending cuts) to be named later.

Update: An informed reader directs me to the source for the $52 billion figure (see page 13), which makes clear that the proposal is to increase the top two rates, not just the top rate. According to this document, Cinton also proposes to raise additional revenue through the less obvious tax hikes known as PEP/Pease, which make the effective marginal tax rate higher than the statutory rate.

My informed reader says that the Clinton campaign has not taken a position on dividends and capital gains tax rates. Some journalist out there ought to ask the candidate about it, especially in light of the stock market's recent performance.

Sunday, January 20, 2008

What ends recessions?

We analyze the contributions of monetary and fiscal policy to postwar economic recoveries. We find that the Federal Reserve typically responds to downturns with prompt and large reductions in interest rates. Discretionary fiscal policy, in contrast, rarely reacts before the trough in economic activity, and even then the responses are usually small. Simulations using multipliers from both simple regressions and a large macroeconomic model show that the interest rate falls account for nearly all of the above average growth that occurs early in recoveries.

Goolsbee on the Laffer Curve

Saturday, January 19, 2008

Blinder on Fiscal Stimulus

From a few years ago, here is a nice survey from Alan Blinder on the use of fiscal policy as a tool to combat the business cycle. His bottom line:

So my overall conclusion runs something like this. Under normal circumstances, monetary policy is a far better candidate for the stabilization job than fiscal policy. It should therefore take first chair. Nothing in this paper is intended to dispute this piece of conventional wisdom. That said, however, there will be occasional abnormal circumstances in which monetary policy can use a little help, or maybe a lot, in stimulating the economy—such as when recessions are extremely long and/or extremely deep, when nominal interest rates approach zero, or when significant weakness in aggregate demand arises abruptly. To be prepared for such contingencies, it makes sense to keep one or more fiscal policy vehicles tuned up and parked in the garage, and perhaps even to adopt institutional structures that make it easier to pull them out and take them for a spin when needed.

The relevant question is whether the current situation, with unemployment at 5 percent and a consensus near-term growth forecast of about 1 percent, qualifies as one of these "occasional abnormal circumstances."

Friday, January 18, 2008

Fiscal Stimulus and Fed Policy

If some journalist out there talks to a member of the Federal Open Market Committee, here is the question I would ask:

If the economy now gets the fiscal stimulus being proposed (about 1 percent of GDP), does that mean that the Federal Reserve will cut interest rates less than it otherwise would?

My follow-up questions:

If the answer to the first question is No, then ask, Why the heck not? Monetary and fiscal policy are two tools available to increase the aggregate demand for goods and services. The goal here is to prop up demand sufficiently to maintain full employment without causing inflation. If the U.S. government is using fiscal policy more, it should use monetary policy less.

If the answer to the first question is Yes, then ask, How much higher will interest rates be kept as a result of the fiscal stimulus? And is it really better to have a fiscal stimulus and higher interest rates than a smaller deficit and lower interest rates?

CEO of the Princeton Econ Department

Thursday, January 17, 2008

Looking for a Summer Job

An ec 10 student emails me a question:

Dear Professor Mankiw,

I am interested in doing some economics-related research this summer. It seems difficult for a freshman with only a semester of Ec-10 to get an internship in this area, but I wanted to see if you had an ideas or knew of any places I should look

Thanks for your time,[name withheld]

Yes, it is hard for a freshman to land a good research-related job. But it is not impossible. When I was a freshman, I managed to get a summer job as a research assistant to Princeton professor Harvey Rosen mainly because, I suspect, I knew enough Fortran programming to be useful in his research project. Harvey is a great economist and an all-round terrific human being, and I learned a lot working for him.

The main difficulty for freshmen is that you are competing with more advanced students for research assistant jobs. Given the work that I do, I tend not to hire a lot of student assistants, and when I do, they are usually grad students.

Other professors have different styles and larger demands. Sometimes job postings can be found at the undergraduate office in the economics department, but the only way to know for sure if professors are hiring is to email them or knock on their doors to ask. As you are searching, don't forget that you can find good economists not only in the economics department but also at other parts of the university such as the business school and the Kennedy school of government.

In addition, for students interested in economic policy, there are internship programs at policy organizations such as the CEA, CBO, Fed, and NY Fed, and policy think tanks such as AEI, Brookings, Cato, and Heritage. This is the time of year when students should start applying.

Should the winners from free trade compensate the losers?

Anna dings the Fed

As rebukes go in the close-knit world of central banking, few hurt as much as the scathing indictment of US Federal Reserve policy by Professor Anna Schwartz.

The high priestess of US monetarism - a revered figure at the Fed - says the central bank is itself the chief cause of the credit bubble, and now seems stunned as the consequences of its own actions engulf the financial system. "The new group at the Fed is not equal to the problem that faces it," she says, daring to utter a thought that fellow critics mostly utter sotto voce.

Tuesday, January 15, 2008

CBO on Fiscal Stimulus: A Strange Menu

Some of the proposals on the table strike me as particularly odd. For example: a temporary increase in food stamp benefits.

In standard macroeconomic theory, the business cycle is symmetric. That is, stimulating an economy that is suffering from insufficient aggregate demand should be the opposite of cooling off an overheated economy to reduce inflationary pressures. Would anyone seriously propose a temporary cut in food stamp benefits in an overheated economy? I don't think so. Food stamps seem the wrong tool to address the business cycle.

By contrast, the first line of defense against short-run economic fluctuations--monetary policy--is applied symmetrically. You cut money growth and raise interest rates in an overheated economy, and you increase money growth and lower interest rates in a lackluster one.

As always, thanks for using your blog as a means to educate your readers through discussion and debate. I was surprised to see you single out food stamps as an example of what is wrong with fiscal stimulus. At a minimum the same logic would apply to every other fiscal stimulus option. You are correct that policymakers do not cut food stamps in order to restrain an overheated economy. Then again, policymakers do not generally raise taxes during booms either—if anything it is the opposite and the transitory revenue boost associated with an overheated economy is often employed as an argument for more tax cuts.

The Congressional Budget Office menu is responsive to the question policymakers from both parties are asking today: if we want to increase aggregate demand in the short run, what is the best way to do it. And a temporary increase in food stamps is, appropriately, high up on this list. Food Stamp administrators could simply press a button and everyone’s electronic debit cards would have, say, an additional 20 percent more money starting almost immediately and ending whenever policymakers want. Plus as Marty Feldstein explained: “Food stamps strikes me as a pure cash transfer to people with a high propensity to spend and people who would not benefit from a tax cut.” Tax rebates are administratively more difficult and have somewhat lower bang-for-the-buck, but have the big benefit of being scalable to the size policymakers desire – which is why Doug Elmendorf and I recently included them in our list of more effective stimulus options.

You might be convinced that food stamps are no worse than any of the other options and, from a purely technocratic point of view, even somewhat better. But what about the case for fiscal stimulus in general? An economist king would use both fiscal and monetary policy to stabilize aggregate demand. In particular, because monetary policy takes about a year to significantly impact the economy, the economist king would well-designed fiscal policies like tax rebates and food stamps to affect aggregate demand over three to six month horizons.

I have not written down the model, but I suspect that even if the economist king was constrained to use asymmetric fiscal policy (i.e., fiscal expansions timed to downturns but no fiscal contractions timed to booms) it would still be better to use a combination of fiscal and monetary policy to stabilize the economy than to eschew fiscal policy altogether.

Of course, reality falls a considerable amount short of even the asymmetric economist king. Just how far short is a difficult judgment and entails weighing the benefits of fiscal stimulus done right against the costs of fiscal stimulus done wrong. But given that policymakers have now chosen to undertake fiscal stimulus, one important task for economists is to help them sort through their options so that the end result is at least a little bit closer to what an economist king would do.

Jason

Greg again: Marty Feldstein may well be right that those on food stamps have a higher-than-average marginal propensity to consume. Nonetheless, I wonder if we really want to target such cyclical measures on the poorest members of society. That is, for any mean level of food stamps, wouldn't the poor be better off with a constant stream of benefits than with a benefit that fluctuates over the business cycle? Using food stamps as a cyclical tool seems to risk destabilizing some families' food consumption in an attempt to stabilize the overall business cycle.If we are going to use fiscal policy to smooth out the business cycle on a regular basis, then we should think harder about improving the economy's automatic stabilizers. For example, imagine we enacted an investment tax credit, the size of which was a function of the unemployment rate. Firms would have an incentive to time their investment projects toward those periods when the economy was weakest and most needed a shot in the arm.I can more easily imagine, when the economy starts to overheat, telling corporations that their investment credit has shrunk or disappeared than telling poor families that their food budget has been cut.

The signs point increasingly to an imminent, or perhaps already begun, recession.

By contrast, my favorite forecasting services believe that we will have a few quarters of slow growth--say, around 1 percent at an annual rate--but manage to avoid an actual recession as determined by the NBER. (This used to be called a growth recession.)

One hears that George W. Bush likes to give people nicknames. So I hereby propose that he himself be known as Chicken Little. After all, he has been running around saying ''The sky is falling! Hurry up and pass my tax cut!'' And that of course means that we should dub Dick Cheney, who has been the administration's point man for economic pessimism, Chicken Big Time.

With one exception, the economic data don't support such gloomy views. The unemployment rate has ticked up slightly, but it is still lower than anyone would have thought possible only a few years ago -- and in much of the country labor markets remain tight. Business payrolls actually expanded faster from November through January than they did in the previous three months....

There's no mystery about why the administration is so eager to pronounce the economy flat on its back -- Mr. Bush wants to use fear of recession to bully Congress into rushing through his tax cut, without worrying about little details like whether it would actually help, or whether we can actually afford it. But it's still a remarkable departure from the usual principles of economic policy. Has there ever before been a case of a U.S. administration deliberately undermining confidence for the sake of political advantage?

Monday, January 14, 2008

Freeman on the Colbert Report

CBO rebuts Hacker

Substantial interest has arisen recently regarding how much household income and workers’ earnings bounce around from year to year, prompted in part by the work of Jacob Hacker at Yale University. This topic is important not only to understand potential sources of household anxiety, but also in designing social insurance systems and the tax code.

In previous work released in 2007, CBO examined the volatility of workers’ earnings. That report concluded that earnings were surprisingly volatile, but had been roughly as volatile since the early 1980s — in other words, earnings volatility had not increased....

CBO has now examined the volatility of household income (rather than workers’ earnings volatility, the subject of our study in 2007). The preliminary results suggest that household income is much less volatile than individual worker’s earnings, and that household income volatility has not increased over time — and perhaps even declined slightly. Some other recent studies relying on other data sources have suggested increases in household and family income volatility, but various problems in the surveys used in those studies may be contaminating those results.

Sunday, January 13, 2008

The Gary Becker Health Reform Plan

Time to leave Massachusetts?

When retired people move to a warmer state, their life expectancy rises dramatically. In fact, 8 to 15 percent of the increase in American life expectancy over the last 30 years comes from people moving to warmer climates.

Saturday, January 12, 2008

Eyes on the Fed

According to options data analyzed by the Cleveland Fed, the Fed Funds rate will soon be coming down to 3.75 and maybe even 3.5 percent, from the current target of 4.25 percent. (Click on the graph to enlarge and see how the implied probabilities have changed over time.)

An Anonymous Citation

WALLACE: Mayor Giuliani, you announced plans for a big tax cut yesterday. And you have been running ads that say reducing taxes actually will increase revenues. But the bipartisan Congressional Budget Office, as well as two chairmen of President Bush's Council of Economic Advisers, all say that tax cuts don't pay for themselves, that in fact they add to the deficit, they don't reduce it. So, given that, do you stand by your statement?

GIULIANI: Well, the reality is that some tax cuts do add to revenues. Other tax cuts don't add to revenues. It depends on the tax cut. And tax cutting has been part of the Bush program, the Reagan program, the Kennedy program, and it always led to significant increase in economic activity.

The Club for Growth looked at our plan, which is the biggest tax cut in history, and said that it would be a significant improvement in the economy and it would add to growth in the economy. Now, let me give you an example.

If you cut something like the corporate tax at 35 percent, you bring it down to 30 percent, you will get more revenues from that cut, because our corporate tax is the second highest in the world. If you cut some other tax, you might not get those kinds of revenues.

Friday, January 11, 2008

Health Reform from an Ec 10 Father

From my inbox:

Hello Professor Mankiw,

I am a cardiologist, my daughter is a former ec10 student of yours. I enjoy your blog and hope you will indulge me on my idea.

For the same price as lst dollar coverage, our family has an HSA which allows us about $1000 per family member per year to spend before we hit the deductible. What we don't spend grows tax-free and we rarely spend the max. Think if everyone had the same incentive--even Medicare and Medicaid!

Then get all the labs, outpatient centers etc to list prices for procedures. When the doctor says "you need a stress test" let the patient shop around--maybe traveling 1 hr could save them $200-300.

The next thing is to make each individual responsible for his own medical records with a small digital recording device like an IPOD. Every time they get an X-Ray, a lab test, stress test, doctor visit- it would be recorded. When the patient sees me in the office I can plug it in and see what tests have been done and get the results and download them into my file. Why should we have a national system of computers and databank when each individual can carry their own with them? I like the idea of personal responsibility!

Huckabee's Tax Plan

Funny, perhaps, but illogical

Mr. Huckabee, for his part, responded with trademark humor. “The Air Force has a saying that says if you’re not catching flak, you’re not over the target,” he said. “I’m catching the flak; I must be over the target.”

Similarly, if you're not an American citizen, you're not President of the United States. I am an American citizen, so I must be President of the United States.

Economists Take on Traffic Safety

Thursday, January 10, 2008

A New Survey of Economists

The latest Wall Street Journal survey of economic forecasters sees rising odds of a U.S. recession this year along with mounting inflationary pressures, an uncomfortable mix that could influence the focus of the presidential campaign and complicate life for the Federal Reserve. The economists now put the odds of recession at 42%....When asked whom they expect to win the presidency in 2008, 63% of the economists in the survey picked a Democrat.... However, when asked their personal preference, the economists favored Republicans. Sen. McCain led the field with 39% of the vote, compared to 11% for Mr. Giuliani and 7% for former Massachusetts Gov. Mitt Romney. Sen. Obama edged Sen. Clinton among Democrats, 14% to 11%, while former North Carolina Sen. John Edwards took 4%.

Corporate insiders are bullish

Consider data collected by the Vickers Weekly Insider Report, published by Argus Research. If anything, they show the average insider to be even more bullish on his company's stock than he was three weeks ago.

Vickers calculates a ratio of the number of shares that corporate insiders recently have sold to the number that they have purchased. According to Vickers, any ratio below 2.00 is a bullish sign.

For the eight-week period ending Dec. 14, this ratio stood at 1.74. For the eight weeks ending last Friday, in contrast, the ratio was an even more bullish 1.47.

Sunday, January 06, 2008

The Pigou Club watches the debates

MR. GIBSON: All right. Let me turn to something else. Reversing -- you invoked the name of Al Gore a few moments ago. Reversing or slowing global warming is going to take sacrifice. I'm sort of sorry Chris Dodd isn't here because he's talked a lot about a carbon tax in this election. Al Gore favors a carbon tax. None of you have favored a carbon tax. Is it a bad idea? Or is it just so politically unpalatable that you guys don't want to propose it?

GOV. RICHARDSON: It's -- can I answer? You know, I was Energy secretary. It's a bad idea because when you have a carbon tax, first of all, it's not a mandate. What you want is a mandate on polluters, on coal companies, on -- on -- on those that pollute to reduce greenhouse gas emissions by a certain target -- under my plan, 30 percent by the year 2020, 80 percent by the year 2040. It takes international leadership.

The better way to do it is through a cap-and-trade system, which is a mandate. Furthermore, a carbon tax, that's passed on to consumers. That's passed on to the average person. That's money you take out of the economy. So it's a bad idea. Cap-and-trade is mandate, but it's also going to take presidential leadership. It's going to take all of us here, every American, you know, to think more efficiently about how we transport ourself, what vehicles we purchase, appliances in our homes.

It's going to take a transportation policy that doesn't just build more highways. We have to have commuter rail, light rail, open spaces. We got to have -- we got to have land use policies where we improve people's quality of life.

MR. SPRADLING: Senator Obama?

SEN. OBAMA: Well, I agree with Bill, that I think cap-and-trade system makes more sense. That's why I proposed it because you can be very specific in terms of how we're going to reduce the greenhouse gases by a particular level. Now what you have to do is you have to combine it with a hundred percent auction. In other words, every little bit of pollution that is sent up into the atmosphere that polluter is getting charged for it. Not only does that ensure that they don't game the system, but you're also generating billions of dollars that can be invested in solar and wind and biodiesel.

I do disagree with one thing, though, that Bill said, and that is that on a carbon tax the cost will be passed onto consumers and that won't happen with a cap-and-trade. Under a cap-and-trade there will be a cost. Plants are going to have to retrofit their equipment, and that's going to cost money, and they will pass it onto consumers. We have an obligation to use some of the money that we generate to shield low-income and fixed-income individuals from high electricity prices, but we're also going to have to ask the American people to change how they use energy. Everybody's going to have to change their light bulbs. Everybody's going to have to insulate their homes. And that will be a sacrifice, but it's a sacrifice that we can meet. Over the long term it will generate jobs and businesses and can drive our economy for many decades.

For the passages I put in bold, Bill Richardson and Barack Obama deserve special note, for opposite reasons. As a former energy secretary during the Clinton administration, Richardson has presumably studied these issues. But here he demonstrates extraordinary ignorance (or perhaps extraordinary disingenuousness) about the economic impact of cap-and-trade systems. By contrast, Obama shows extraordinary clarity and honesty about the effects of the policy he is proposing.

The economics is straightforward and uncontroversial. Both carbon taxes and cap-and-trade systems put a price on carbon, raising the cost of producing carbon-intensive products such as gasoline. In both cases, this cost will be passed on to consumers. The government can, however, raise revenue through a carbon tax or auction and use that revenue to reduce other taxes and help offset the adverse income effect.

In case you are curious, Hillary Clinton is the next speaker on this question, but she does not weigh in on the particular issue of carbon taxes vs cap-and-trade. Instead, she offers some typical vacuous blather about requiring utility companies to help us all become more energy efficient. I think of this as "magic-wand economics." Like your fairy godmother, the President can wave a magic wand and make your problems disappear.

Congratulations, Raj

Blinder on Inequality and Trade

Many Americans are justifiably distressed about rising income inequality, but foreign competition gets far too much of the blame. In fact, the best and most comprehensive studies of the inequality question assign international trade only a bit part in the drama. The main protagonists are all domestic.

Friday, January 04, 2008

Ben's Choice

"Mr. Bernanke, whose term is up for renewal in 2010, certainly wants to avoid a recession. But he would probably prefer a mild recession now to a high risk of increased inflation and a deeper recession later." From Greg Ip

Thursday, January 03, 2008

Rogoff: Time for a Carbon Tax

Future historians will almost certainly regard the failure of the United States to lead in global environmental policy as an even greater mistake than the invasion of Iraq. The first thing the next American president should do upon taking office is to insist that the U.S. Congress pass a huge increase in gas taxes. To be more precise, the United States should implement steep carbon taxes that hit coal, heating oil, and natural gas. The tax should be enough to raise the price of gasoline by at least $2 a gallon. But unlike Europe’s consumer-oriented gasoline tax, it should hit everyone in the economy, including manufacturers.

No other specific policy action will be half as effective in changing America’s engagement with the world. No other presidential directive would so clearly disown the United States’ record of lamentable and self-centered head-in-the-sand energy policies. There is no way the United States can hope to persuade China and India to adopt more environmentally friendly growth strategies without first acknowledging its own responsibility—and then doing something about it. At the same time, a carbon tax might finally convince the rest of the world that the United States does not aim to invade countries to preserve cheap oil.

Such a tax would raise massive revenues that will help reduce current and prospective U.S. deficits. The revenues would help ease the pressure that excessive American borrowing is putting on international capital markets, pressure that is now contributing to a dangerous collapse of the dollar. Of course, some of the new tax revenue should be earmarked for scaling back other taxes and for providing subsidies to low-income citizens to offset the burden of the carbon tax.

Expert Coin Flippers

Many studies have shown that mutual fund managers with a history of superior performance usually fail to maintain it in subsequent periods--a result that does not surprise supporters of the efficient markets hypothesis. Today's Wall Street Journal gives an example of this phenomenon (although the paper seems to be promoting the funds, rather than drawing the logical inference from the numbers).

As shown above, the Journal reports that of the many thousands of mutual funds sold to the public, only 31 beat the Standard & Poor’s 500 index in each of the 8 years from 1999 to 2006. A skeptic of the efficient markets hypothesis might think that, subsequently, these funds would offer a better-than-average place to invest. In 2007, however, only 14 out of these 31 outperformed the index—about what would be expected from sheer chance. Exceptional past performance appears to give little reason to expect future success.

Let me venture a guess about how many of the remaining 14 will see their winning streak continue another year: 7.

The FairTax

Wednesday, January 02, 2008

Bob Shiller as Financial Engineer

Economists are often surprised by the strange instruments that get attention in financial markets. Conversely, we are often disappointed that the hedging instruments we think should be important either don't exist or, when they are created, don't get as much attention as we think they deserve. (For example, like many other economists, I have long been puzzled by the absence of a large, vibrant market in inflation-adjusted annuities. I hope it develops before I retire.)

Yale economist Robert Shiller, a pioneer in financial economics, is now struggling with our meager understanding of the demand for risk avoidance. The Wall Street Journal reports that his new hedging instruments are not being eagerly received:

Other products also continue to experience trading issues, like the MacroShares oil shares that encountered trouble last year. The products were developed by Yale economist Robert Shiller to track crude-oil futures prices but have continued to trade at a wide "spread," or difference, from their underlying shares. The firm conducted a 3-for-1 stock split to try to reduce the products' share price and encourage buying.

MacroShares has also split from its partnership with Claymore Securities, dropping the Claymore name. In November, the MacroShares Oil Down product was trading at as much as an 80% premium to its net asset value, which ETF prices generally closely match, while the MacroShares Oil Up product traded at a 20% discount.

"Kill These ETFs, now" wrote Greg Newton on markets Web site Naked Shorts at the time. "The MacroShares are irretrievably broken" and "a disgrace to the ETF market."

"I think there's been some misconception about the pricing of the securities," says Mr. Shiller. He has been talking to government officials in Dubai and Norway about how the MacroShares could be appealing for hedging oil bets in their investment funds. "I've tried to get the message across, but it's been hard."

About Me

I am the Robert M. Beren Professor of Economics at Harvard University, where I teach introductory economics (ec 10). I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.